Repo, Security, Collateral Management –are we on the right track? - Godfried de vidts

Repo, Security, Collateral Management – are we on the right track?

Godfried De VidtsChairman of the ICMA European Repo CouncilDirector of European Affairs, ICAP

Vienna 29th May 2015

Legislative action/non-action since the creation of the Giovannini group

Repo market update

Liquidity in fixed income = liquidity in repo market

CSDR – the final nail in the coffin?

Agenda

Plus ça change….

Frederik Bolkenstein

‘Giovanninibarriers’

Michel Barnier

‘Hands-on’

Charles McCreevy

‘Hands-off’

Lord Hill

‘CMU’

Regulatory alphabet soup…..

DGSD

CRAR I/II/III / CRAD

MiFIR / MiFID II

MAD / MARMMFR

SFTR

S II

BSRR

ESFS – ESRB / ESAs

ICSD

FCD

SSR

MCD

CRD III

EVCF

AIFMD FROD

TD

ESEF

SAR / SAD

CSDR

PRIIPS

IORP

Omnibus II

NFRD

AMLD / AMLR

IMD

UCITS VSSM

FBRQE

EMIR

LTRO

VLTRO

OMT

NB: Full write out of all will be in the minutes

CRR / CRD IV: LCR/NSFR/

Leverage

VLTRO

TLTRO

BRRD

European Repo Council28th European repo market surveyconducted in December 2014

Headline numbers

28th European repo market survey conducted in December 2014

EUR 5,500bn

Jun-10Jun-07

Lehman

Dec-08

LTRO

ICMA survey v FRBNY primary dealer reports


USD 4,254bn

Jun-08

Lehman

Dec-09

LTRO

Trading analysis


bilaterally-negotiatedby phone or EM

bilaterally-settled

bilaterally-negotiated by phone or EMtriparty-settled

arranged by voice-brokerbilaterally-settled

automatic trading systemincludes GC Pooling

bilaterally/triparty/CCP-settled

Trading analysis


Lehman LTRO

Business cleared across CCP


Lehman LTRO

Currency analysis


Currency analysis


Lehman LTRO

Collateral analysis


Collateral analysis


Lehman LTRO

Collateral analysis


Lehman LTRO

Collateral analysis


EU non-

govis

18.5%

(20.7%))

EU govis

81.5%

(79.3%))

Collateral analysis


Collateral analysis


Lehman LTRO

Maturity analysis


short dates

= 55.4% (60.3%)

Rate analysis


Product analysis


repo

89.3%

lending

10.7%

ICMA secondary credit market study

Andy Hill

The current state and future evolution of the European investment grade corporate bond secondary market: perspectives from the market

CSDR Mandatory Buy-ins Impact Study

An initiative of the ICMA Secondary Market Practices Committee (SMPC)

A response to increasing concerns about market liquidity and economic risks

A qualitative study

Focus on European IG non-financial and financial corporate issuance, but overlaps with other asset classes

Semi-structured interviews with key market participants: bank broker-dealers, asset managers & investment funds, trading platforms, issuers

July – October 2014: 38 interviews, 34 firms, 47 individual participants

Published end of November 2014

The study

“Corporate bond markets can be considered an important ingredient in economic growth, financial stability and economic recovery, particularly in the wake of the crisis. They provide a key capital funding flow to firms allowing them to expand, innovate, offer employment, and provide the goods and services societies demand.”

- IOSCO, 2014, ‘Corporate Bond Markets: A Global Perspective

Corporate bond markets and the real economy

The growth of the global bond markets

0.0

10,000.0

20,000.0

30,000.0

40,000.0

50,000.0

60,000.0

70,000.0

80,000.0

90,000.0

Mar 94Mar 07

Mar 14

US$

bill

ion

s

Total Debt Securities $billions

Non-Financial Corporatoins

Financial Corporations

General Government

Total (all issuers)

Source: BIS Quarterly Review, September 2014

The size of the European bond markets

Source: European Central Bank

€ 3,759

€ 2,456

€ 899

€ 6,664

€ 617

Outstanding Euro denominated debt securities €billions (Aug 2014) Total: €14,396 bn

Monetary financial institutions

Financial corporations other than MFIs

Non-financial corporations

Central government

Other general government

Key-themes coming out of the study

The death of liquidity

Changing business models

Market transparency

Electronification of the market

The issuer perspective

The risks from future regulation

The next crisis?

“Liquidity is the ability to get a price in any instrument, in any size, at any time.”

- Fund manager

Means different things to different participants

2002-2007 a liquidity bubble? [CDS/structured derivatives]

Dynamic (market cycles and bond life cycles)

Quantifiable? As much a state as a measure

“The golden age of liquidity was a very brief period, and driven by leverage.”

- Credit trader

What do we mean by liquidity

The death of liquidity

“The main issue facing the investment grade Eurobond markets today is the lack of liquidity.”

-Fund manager

Overarching theme

Basel III capital requirements; leverage ratios; EMIR, Volcker

Market conditions (QE, low rates, low volatility, tight credit spreads)

No markets in size: more agency broking (an excuse?)

Investors contribute to illiquidity (‘winner’s curse’)

Corporate bond markets inherently not liquid

Changing business models

“The sell-side used to give liquidity away for free; now, if the buy-side wants it, they should pay for it”

- Credit trader

Better balance sheet allocation and focus on risk-weighted return on capital

Reduced inventories, more client/axe focused (commission based model?)

More niche players

Down-sizing and down-grading of bank broker-dealers

Change in investor behaviour

“Investment managers may become driven more by liquidity considerations, rather than by valuations or investment strategies”

- Fund manager


“When liquidity does come back, there will be fewer people and more technology”

- E-platform founder

Increase in use, and expected to grow with more entrants

Improved scope for connectivity (‘all-to-all’ /‘buy-side-to-buy-side’)

Big data to support more ‘intelligent’ broking models

Virtual liquidity

A replacement for market-making?

The issuers perspective

“We have enjoyed good market conditions; there is a lot of cash around, it is difficult to be overly concerned”

- Corporate issuer

Market has been good, but issuers becoming increasingly concerned

Secondary markets help price primary issuance

Selection of banks to award lead manager mandates?

Standardized issuance?

The risks from future regulation

MiFID II/MiFIR: pre and post trade transparency requirements

The winners curse (the transparency paradox)

Confusion between transparency and liquidity

“Transparency is fine for retail trades, but it will kill the wholesale market”

- Credit analyst

CSDR: mandatory buy-ins

A solution looking for a problem

The end of short-selling

“Mandatory buy-ins will be the final nail in the coffin of market liquidity”

- Credit trader

The next crisis?

“This is a classic bull market; valuations have gone out the window”

- E-platform provider

A common thread in the various discussions with all participants is the inevitability of the meltdown in global credit markets.

Regulation has shifted risk from banks to investors

While market cycles are nothing new, the common concern is that, largely because of regulation, financial markets have never been worse placed to deal with a sharp correction.

A combination of larger bond markets, with fewer, larger investment firms, and a weakened capacity for bank intermediation, all makes for the perfect storm.

While some see the lack of liquidity in the secondary markets as exacerbating any correction, while others are more concerned about how a non-functioning secondary market could impede any return to normality.

Possible solutions


Big data

Cross-market networking/connectivity

Dark pools

‘Intelligent broking’

‘Virtual liquidity’

But: is it substitute for market-making?

Issuer initiatives

More selective awarding of mandates

Standardized issuance

But: is it the responsibility of issuers?

Better regulation

Winners and losers?

Functioning and efficient markets a social good

Connection between market regulation and real economy

Conclusion

The interviews for this study suggest that the European investment grade credit market is a dramatically changing landscape.

Liquidity, by most definitions, is rapidly evaporating, primarily as a result of financial regulation and extraordinary monetary stimulus.

Banks and investors are adapting to the new environment, as are electronic intermediaries who are looking to provide possible solutions. Issuers, as yet, are relatively unaffected, but are becoming increasingly concerned.

While a number of market led solutions are being discussed, at some stage the impact of regulation on market liquidity and efficiency will need to be considered, not least as the role of capital markets in supporting economic growth comes ever more into focus.

Conclusion

Ultimately, if the challenges facing the corporate bond secondary markets are to be addressed and solutions found this will require the constructive and coordinated effort of all stakeholders: market-makers, investment managers, trading platforms and intermediaries, the issuers, and the various regulatory bodies and authorities.

Functioning and efficient capital markets are a social good that support economic activity and growth. For those who provide, use, and oversee capital markets, this should be a collective responsibility.

ICMA European Repo Market Survey& CSDR Mandatory Buy-ins Impact Study

ICMA Impact Study for CSDR Mandatory Buy-ins February 2014

Study Overview:

Objective to establish the impact of introducing a mandatory buy-in regime on European bond and repo market pricing and liquidity

ICMA surveyed major fixed income market-makers to ascertain increase in offer prices to cover increased buy-in risks and anticipated associated costs

Impacts assessed for 3 main asset classes: Sovereign, Public, and Corporate bonds

Impact assessed for both outright cash bond offers and one-month repo offers

Price adjustments based on current MiFID II draft RTS for pre- and post-trade liquidity calibrations and current CSDR draft RTS for buy-in extension periods


Summary of main impacts

Liquidity across secondary European bond and financing markets will reduce significantly, while bid-offer spreads will widen dramatically.

The results suggest that even the most liquid sovereign bonds will see bid-offer spreads double, while secondary markets in less liquid corporate bonds may effectively close.

For many less liquid bonds, including sovereign and public issues, market-makers will retrench from providing offers-side liquidity altogether.

The €5.5 trillion European repo market will also be radically re-shaped, driving more reliance on very short-dated repo funding (‘exempt’ repo), while the more stable, fixed-term repo markets will see dramatic widening of spreads for more liquid securities, and a total withdrawal of liquidity for less liquid securities, including some sovereign and public bonds, and most corporate bonds.


The impact on bond market bid-offer spreads


0.0

50.0

100.0

150.0

200.0

Sovereign

LiquidSovereign

Illiquid Public LiquidPublic Illiquid

Corporate

Liquid Corporate

Illiquid

Cen

ts

Impact on bond market bid-offer spreads

Current Spread

Increase in Offer

New Spread

The relative increase in bond market bid-offer spreads


0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

140.0%

160.0%

Sovereign Liquid Sovereign Illiquid Public Liquid Public Illiquid Corporate Liquid Corporate Illiquid

% increase in bid-offer spread

Percentage of respondents who will cease to offer bonds unless pre-positioned


0%

5%

10%

15%

20%

25%

30%

35%

40%

Sovereign Liquid Soveregin Illiquid Public Liquid Public Illiquid Corporate Liquid Corporate Illiquid

% of respondents who will cease to offer bonds unless pre-positioned

Estimating the cost to the bond markets


Estimated cost per €1tn of volume

The impact on one-month repo bid-offer spreads


0.0

20.0

40.0

60.0

80.0

100.0

120.0

Sovereign

Liquid Sovereign

Illiquid Public LiquidPublic Illiquid

Corporate

Liquid Corporate

Illiquid

Bas

is P

oin

ts

Impact on 1 monthrepo bid-offer spreads

Current Spread

Increase in Offer

New Spread

The relative increase in 1mth repo bid-offer spreads


0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

140.0%

160.0%

180.0%

200.0%


% increase in bid-offer spread

Percentage of respondents who will cease to offer term repo


0%

10%

20%

30%

40%

50%

60%


% Respondents who will cease to offer term repo

Estimating the cost to the repo markets


Based on June 2014 data

Conclusions

Mandatory buy-ins will present a significant cost (and reduced liquidity) to the bond and repo markets that will be borne by the end users (i.e. investors and issuers).

It is unlikely that it will improve settlement efficiency, and given the impact on bond and repo market liquidity, is likely to worsen it.

Applying the MiFID liquidity calibrations to determine extension periods will amplify the negative impacts on pricing and liquidity.

Applying the maximum allowable extension period for all fixed income (7 days) could significantly reduce the negative impacts on liquidity and overall costs of the regulation.

The study supports the case for delaying implementation until post-T2S and to allow for a thorough impact assessment that also takes account of QE.


Economy & Finance

Repo, Security, Collateral Management –are we on the right track? - Godfried de vidts